First official analysis of Government's flagship pension reforms show more
than 130,000 Britons a year will withdraw money from funds

More than 650,000 savers are preparing to take advantage of George Osborne’s flagship pension reforms over the next five years, providing the Government with a £4 billion tax windfall, the first official analysis of the scheme has revealed.

The research has found that under the reforms, which scrap rules that currently force most Britons to buy an annuity, more than 130,000 Britons a year will withdraw money from their pension funds.

The figures suggested savers will take out around £26 billion from their pension pots in five years, equivalent to just under £40,000 each. This will boost Treasury coffers by £3.8 billion between 2015 and 2020 as pensioners are hit by higher levels of tax, according to the figures.

Pension experts warn that many savers will withdraw more than they need and could find themselves dragged into the higher rate tax band.

Tom McPhail, head of pensions research at financial services firm Hargreaves Lansdown, said: “A lot of people are clearly very interested in taking advantage of the new pension freedoms, however many of them probably don’t realise that they could end up losing nearly half their pension pot in tax.

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“It is essential that suitable safeguards are put in place to ensure that they are alerted to the tax implications of taking all their money out. This is undoubtedly clever politics from the Chancellor but if we’re not careful he could end up creating a one-man pension mis-selling scandal.”

David Smith, a director of wealth management firm Tilney Bestinvest, said: “The big concern is that insurance companies are not going to provide any guidance at all on the tax implications of pension withdrawals.

“If someone rings up to take their money out, it is vital they are given a warning.”

Malcolm McLean, a pensions consultant at advisory firm Barnett Waddingham, said: “There is evidence to suggest that the majority of savers don’t understand these reforms and think they can treat their funds like a bank account.

“That is a major problem because if they make a large withdrawal, for example to invest in buy-to-let property, they could get stung by a 40 per cent or 45 per cent tax charge.”

In his Budget this year Mr Osborne scrapped rules that force most Britons to use their pension savings to buy an annuity.

This will make it easier and cheaper for people to withdraw money directly from their pension pots from April 2015.

The Chancellor has said it is time to end the “patronising” view that the “state knows best how people should spend their money”.

Ministers have even said they would be “relaxed” if people choose to spend their life savings on a Lamborghini.

However, documents published by HM Revenue and Customs (HMRC) confirmed that three-quarters of each withdrawal will still be subject to income tax.

HMRC said it expected to collect an additional £3.86 billion of income tax by 2020, the result of savers making larger withdrawals in the early years of retirement, bringing forward the taxation of their retirement income.

Tax is charged at 40 per cent when a person’s income reaches £41,866.

Mr McPhail said many people might breach this threshold in the early years following the reform. The alternative, he said, was spreading the money over several years and so keeping income taxes to 20 per cent.

HMRC said it estimated 130,000 people a year will access their pensions “flexibly”.

Savers will be able to withdraw their entire life savings at once, or take smaller portions as required.

In an attempt to stem concerns about the scheme, the Government plans to offer millions of pensioners who choose to reinvest their pensions free and impartial advice. The taxman’s impact assessment yesterday showed the amount of extra tax collected as savers access more of their pensions is expected to rise from £320 million in 2015-16 to £1.2 billion in 2018-2019, before falling to £810 million in 2019-20 and declining steadily.

A Treasury spokesman said: “This is the most radical reform to how people access their pension in almost a century and gives choice back to individuals by trusting them with their own finances.”

Q&A

What is happening?

From April, savers aged 55 or over will have full discretion over the use of retirement savings. Pensioners who have already bought an annuity to provide an annual income will not be able to use the freedoms. Neither will members of most public sector schemes. Savers with private final salary pensions will be allowed to transfer to personal pensions to access their funds.

How much can I withdraw?

There are no limits. Partial or full withdrawals will be allowed.

Is it taxable?

A quarter will be tax-free. This could be taken immediately, leaving the rest in the pot, or a saver could opt to receive 25 per cent of each withdrawal tax-free. The remaining three-quarters will be treated as income, taxed at marginal rates. The income is added to any other payments for that year.

What can I do to avoid it?

Use multiple transactions. Say you had £100,000. Even with no other income, withdrawing the entirety would drag you into the 40 per cent tax bracket – you might decide to take £30,000 a year to remain a 20 per cent taxpayer.